China's Currency Move Aims to Ease Trade Criticism

By loosening its currency's peg to the dollar, China is seeking to defuse complaints that it keeps its exports artificially cheap, strengthen its hand against inflation and ensure its economy can keep growing at a healthy pace.

The Chinese yuan surged to a record high Monday as Beijing delivered on its central bank's weekend promise of greater flexibility in its exchange rates. World shares rallied as investors took heart from the signal of confidence in China's resilience.

Analysts said the move was not a major shift in foreign policy. They described it instead as a maneuver aimed mainly at countering criticism of Beijing's currency policies before this weekend's summit of the Group of 20 leading economies. Beijing's trading partners have been frustrated by their perennial trade imbalances with China.

"This is a type of 'diplomatese' before the G-20," said Yi Xianrong, a prominent economist at the Institute of Finance in the Chinese Academy of Social Sciences, a government think-tank.

But Beijing's decision to give up the dollar link it imposed two years ago to help its exporters during the recession also shows it recognizes the need for flexibility in its own economic policies.

China's large trade surpluses oblige the central bank to intervene in the exchange market: It buys up excess foreign exchange earnings to keep the yuan's value from rising. Greater flexibility will allow more leeway in China's monetary policies, helping it counter inflation.

"Chinese policymakers are attempting to engineer a scenario that maximizes political goodwill while at the same time minimizes any negative economic impact," said Alaistair Chan, an economist at Moody's Analytics in Sydney.

The shift away from the dollar peg pushed the yuan to 6.7971 on Monday from 6.8272 yuan on Friday. It was a shift of 0.4 percent and an abrupt break from the narrow range around 6.83 yuan to $1 that had held since mid-2008.

The central bank still sets the exchange rate each day before the start of trading and limits daily fluctuations to 0.5-percent. Its announcement late Saturday stressed China's commitment to keeping the currency stable.

Allowing greater flexibility suits China's own needs. Apart from helping Beijing fight inflation, it should encourage manufacturers to improve efficiency and reduce the country's reliance on exports as a driver for growth, the central bank said.

By ruling out any one-time major revaluations, the People's Bank of China also doused speculation over such moves and removed a source of uncertainty for investors. China's share market responded by jumping nearly 3 percent Monday.

"China has to keep the currency stable under the current circumstances and will certainly take any consequences of the yuan's appreciation very seriously," Yi said.

The decision to revert to a basket of currencies including the U.S. dollar, rather than the dollar alone, to set the exchange rate restores policies in place before the global downturn walloped Chinese manufacturers in 2008. Millions lost their jobs.

China had set up the basket-linked exchange rate system in July 2005, allowing the yuan to gradually gain nearly 20 percent until the financial crisis hit.

China's economy surged 11.9 percent in the first quarter of this year, and exports jumped by nearly 50 percent over a year earlier in May. That was despite expectations that Europe's debt crisis would hit demand in the 27-nation European Union, China's biggest trading partner.

Such trends raised expectations that China would adjust policies that critics say keep the yuan undervalued, unfairly holding down prices of Chinese products overseas and making them impossible to compete with. Beijing's gradual approach to currency reform is a perennial bugaboo in relations with Washington.

U.S. Treasury Secretary Timothy Geithner's immediate praise for the central bank's announcement suggests the move was coordinated to allow him to release a report on China's currency, postponed for more than two months, without having to accuse Beijing of manipulating its currency, Qian Wang, an economist at J.P.Morgan, said in a note to clients.

Geithner delayed the release of the report to allow more time for talks with the Chinese, and the shift in policy is viewed by many as a concession by Beijing.

But President Barack Obama's administration still faces pressure from Congress to name China a currency manipulator, a designation that could potentially lead to U.S. trade sanctions.

"The window was closing for China to act before China-U.S. relations get even more politically charged heading into the U.S. midterm election," Wang said, referring to November's congressional elections.

Though Chinese exporters already operating on razor-thin margins will have to find new ways to stay competitive, the central bank — echoing many economists — noted that such changes are crucial for more balanced, sustainable growth that is less reliant on exports.

"The exchange rate problem is one we would have to face sooner or later," said Bai Ming, deputy general manager of Zhejiang Mingfeng Car Accesories Co., which exports car covers to the Americas, Europe and South Korea.

"What we are trying to do is to raise productivity and save costs. We cannot just sit back," he said.

But while it has prescribed a small dose of currency flexibility for its own economic health, China still rejects accusations that its currency regime is a major cause of huge trade imbalances that contributed to the global crisis.

G-20 leaders should focus on more urgent global reforms, said a commentary Monday by the official Xinhua News Agency.

"If they cannot make good use of the coming G-20 summit to press ahead with the much-needed overhaul of the global financial system, the international community will soon find to its disappointment that its leaders look only for red herrings, rather than real solutions, at a time when true leadership is badly needed," it said.

By loosening its currency's peg to the dollar, China is seeking to defuse complaints that it keeps its exports artificially cheap, strengthen its hand against inflation and ensure its economy can keep growing at a healthy pace.The Chinese yuan surged to a record high Monday...